Principles of Economics, 7th Edition

Published by South-Western College
ISBN 10: 128516587X
ISBN 13: 978-1-28516-587-5

Chapter 8 - Part III - Application: The Costs of Taxation - Questions for Review - Page 168: 2

Answer

Please see the graph. The tax revenue is the orange rectangle in the graph, and the deadweight loss is the green triangle in the graph.

Work Step by Step

The price consumers pay is $P_{T}$, and the price producers receive is $P_{S}$. The difference between $P_{T}$ and $P_{S}$ is the amount of the tax. The original quantity consumed was $Q_{0}$, but with the tax, the new quantity consumed (due to higher prices) is $Q_{T}$. The amount of the tax revenue is $(P_{T}-P_{S})*Q_{T}$. The deadweight loss is created by imposing the tax. The change in quantity is noted as $Q_{0}-Q_{T}$. (This takes the original quantity consumed and subtracts the new quantity consumed.) The price consumers pay is $P_{T}$, and the price producers receive is $P_{S}$. The difference between $P_{T}$ and $P_{S}$ is the amount of the tax. We have a triangle formed by these boundaries, so the amount of the deadweight loss is $1/2*(Q_{0}-Q_{T})*(P_{T}-P_{S})$.
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